Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

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Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Williams-Sonoma, Inc.

Consolidated Statements of Earnings

For the Fiscal Year Ended
(In thousands, except per share amounts)January 29, 2023January 30, 2022January 31, 2021
Net revenues$8,674,417$8,245,936$6,783,189
Cost of goods sold4,996,6844,613,9734,146,920
Gross profit3,677,7333,631,9632,636,269
Selling, general and administrative expenses2,179,3112,178,8471,725,572
Operating income1,498,4221,453,116910,697
Interest (income) expense, net(2,260)1,86516,231
Earnings before income taxes1,500,6821,451,251894,466
Income taxes372,778324,914213,752
Net earnings$1,127,904$1,126,337$680,714
Basic earnings per share$16.58$15.17$8.81
Diluted earnings per share$16.32$14.75$8.61
Shares used in calculation of earnings per share:
Basic68,02174,27277,260
Diluted69,10076,35479,055

See Notes to Consolidated Financial Statements.

Williams-Sonoma, Inc.

Consolidated Statements of Comprehensive Income

For the Fiscal Year Ended
(In thousands)January 29, 2023January 30, 2022January 31, 2021
Net earnings$1,127,904$1,126,337$680,714
Other comprehensive income (loss):
Foreign currency translation adjustments(3,572)(4,488)8,195
Change in fair value of derivative financial instruments, net of tax (tax benefit) of $329, $(91) and $(113)932(247)(315)
Reclassification adjustment for realized (gain) loss on derivative financial instruments, net of tax (tax benefit) of $121, $(371) and $149(341)1,024(410)
Comprehensive income$1,124,923$1,122,626$688,184

See Notes to Consolidated Financial Statements.

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Williams-Sonoma, Inc.

Consolidated Balance Sheets

As of
(In thousands, except per share amounts)January 29, 2023January 30, 2022
ASSETS
Current assets
Cash and cash equivalents$367,344$850,338
Accounts receivable, net115,685131,683
Merchandise inventories, net1,456,1231,246,372
Prepaid expenses64,96169,252
Other current assets31,96726,249
Total current assets2,036,0802,323,894
Property and equipment, net1,065,381920,773
Operating lease right-of-use assets1,286,4521,132,764
Deferred income taxes, net81,38956,585
Goodwill77,30785,354
Other long-term assets, net116,407106,250
Total assets$4,663,016$4,625,620
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities
Accounts payable$508,321$612,512
Accrued expenses247,594319,924
Gift card and other deferred revenue479,229447,770
Income taxes payable61,20479,554
Operating lease liabilities231,965217,409
Other current liabilities108,13894,517
Total current liabilities1,636,4511,771,686
Deferred lease incentives10,02716,360
Long-term operating lease liabilities1,211,6931,066,839
Other long-term liabilities103,794106,528
Total liabilities2,961,9652,961,413
Commitments and contingencies – See Note I
Stockholders’ equity
Preferred stock: $0.01 par value; 7,500 shares authorized; none issued——
Common stock: $0.01 par value; 253,125 shares authorized; 66,226 and 71,982 shares issued and outstanding at January 29, 2023 and January 30, 2022, respectively663720
Additional paid-in capital573,117600,942
Retained earnings1,141,8191,074,084
Accumulated other comprehensive loss(13,809)(10,828)
Treasury stock, at cost: 1 and 4 shares as of January 29, 2023 and January 30, 2022, respectively(739)(711)
Total stockholders’ equity1,701,0511,664,207
Total liabilities and stockholders’ equity$4,663,016$4,625,620

See Notes to Consolidated Financial Statements.

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Williams-Sonoma, Inc.

Consolidated Statements of Stockholders’ Equity

Common StockAdditional Paid-in CapitalRetained EarningsAccumulated Other Comprehensive Income (Loss)Treasury StockTotal Stockholders’ Equity
(In thousands)SharesAmount
Balance at February 2, 202077,137$772$605,822$644,794$(14,587)$(941)$1,235,860
Net earnings———680,714——680,714
Foreign currency translation adjustments————8,195—8,195
Change in fair value of derivative financial instruments, net of tax————(315)—(315)
Reclassification adjustment for realized (gain) loss on derivative financial instruments, net of tax————(410)—(410)
Conversion/release of stock-based awards16997(31,565)——(171)(31,729)
Repurchases of common stock(1,496)(15)(7,569)(142,416)——(150,000)
Reissuance of treasury stock under stock-based compensation plans1——(499)(14)—513—
Stock-based compensation expense——72,186———72,186
Dividends declared———(163,316)——(163,316)
Balance at January 31, 202176,340764638,3751,019,762(7,117)(599)1,651,185
Net earnings———1,126,337——1,126,337
Foreign currency translation adjustments————(4,488)—(4,488)
Change in fair value of derivative financial instruments, net of tax————(247)—(247)
Reclassification adjustment for realized (gain) loss on derivative financial instruments, net of tax————1,024—1,024
Conversion/release of stock-based awards17457(103,742)——(500)(104,235)
Repurchases of common stock(5,103)(51)(26,806)(872,576)——(899,433)
Reissuance of treasury stock under stock-based compensation plans1——(344)(44)—388—
Stock-based compensation expense——93,459———93,459
Dividends declared———(199,395)——(199,395)
Balance at January 30, 202271,982720600,9421,074,084(10,828)(711)1,664,207
Net earnings———1,127,904——1,127,904
Foreign currency translation adjustments————(3,572)—(3,572)
Change in fair value of derivative financial instruments, net of tax————932—932
Reclassification adjustment for realized (gain) loss on derivative financial instruments, net of tax————(341)—(341)
Conversion/release of stock-based awards16687(80,925)——(372)(81,290)
Repurchases of common stock(6,424)(64)(36,134)(843,840)——(880,038)
Reissuance of treasury stock under stock-based compensation plans1——(344)——344—
Stock-based compensation expense——89,578———89,578
Dividends declared———(216,329)——(216,329)
Balance at January 29, 202366,226$663$573,117$1,141,819$(13,809)$(739)$1,701,051

1**Amounts are shown net of shares withheld for employee taxes.

See Notes to Consolidated Financial Statements.

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Williams-Sonoma, Inc.

Consolidated Statements of Cash Flows

For the Fiscal Year Ended
(In thousands)January 29, 2023January 30, 2022January 31, 2021
Cash flows from operating activities:
Net earnings$1,127,904$1,126,337$680,714
Adjustments to reconcile net earnings to net cash provided by (used in) operating activities:
Depreciation and amortization214,153196,087188,655
Loss on disposal/impairment of assets25,1161,01532,365
Amortization of deferred lease incentives(3,019)(4,282)(5,783)
Non-cash lease expense231,350216,888216,368
Deferred income taxes(23,823)2,535(13,061)
Stock-based compensation expense90,26895,24073,185
Other680288(264)
Changes in:
Accounts receivable15,68711,896(31,503)
Merchandise inventories(208,908)(239,981)99,144
Prepaid expenses and other assets(11,823)(2,060)(16,388)
Accounts payable(113,521)56,67425,489
Accrued expenses and other liabilities(61,995)49,460129,142
Gift card and other deferred revenue31,83975,46082,841
Operating lease liabilities(242,855)(224,567)(232,989)
Income taxes payable(18,231)10,15746,933
Net cash provided by operating activities1,052,8221,371,1471,274,848
Cash flows from investing activities:
Purchases of property and equipment(354,117)(226,517)(169,513)
Other162270629
Net cash used in investing activities(353,955)(226,247)(168,884)
Cash flows from financing activities:
Repurchases of common stock(880,038)(899,433)(150,000)
Payment of dividends(217,345)(187,539)(157,645)
Tax withholdings related to stock-based awards(81,290)(104,235)(31,729)
Repayment of long-term debt—(300,000)—
Debt issuance costs—(778)(3,645)
Borrowings under revolving line of credit——487,823
Repayments under the revolving line of credit——(487,823)
Net cash used in financing activities(1,178,673)(1,491,985)(343,019)
Effect of exchange rates on cash and cash equivalents(3,188)(2,914)5,230
Net (decrease) increase in cash and cash equivalents(482,994)(349,999)768,175
Cash and cash equivalents at beginning of year850,3381,200,337432,162
Cash and cash equivalents at end of year$367,344$850,338$1,200,337
Supplemental disclosure of cash flow information:
Cash paid during the year for interest$788$3,090$18,346
Cash paid during the year for income taxes, net of refunds$400,776$306,158$162,842
Non-cash investing activities:
Purchases of property and equipment not yet paid for at end of year$6,633$267$753

See Notes to Consolidated Financial Statements.

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Williams-Sonoma, Inc.

Notes to Consolidated Financial Statements

Note A: Summary of Significant Accounting Policies

Williams-Sonoma, Inc. (“Company”, “we”, or “us”) is a specialty retailer of high-quality sustainable products for the home. Our products, representing distinct merchandise strategies — Williams Sonoma, Pottery Barn, Pottery Barn Kids, Pottery Barn Teen, West Elm, Williams Sonoma Home, Rejuvenation, and Mark and Graham — are marketed through e-commerce websites, direct-mail catalogs and retail stores. These brands are also part of The Key Rewards, our loyalty and credit card program that offers members exclusive benefits across the Williams-Sonoma family of brands. We operate in the U.S., Puerto Rico, Canada, Australia and the United Kingdom, offer international shipping to customers worldwide, and have unaffiliated franchisees that operate stores in the Middle East, the Philippines, Mexico, South Korea and India, as well as e-commerce websites in certain locations. We are also proud to be a leader in our industry with our Environmental, Social and Governance (“ESG”) efforts.

Consolidation

The Consolidated Financial Statements include the accounts of Williams-Sonoma, Inc. and its subsidiaries. All intercompany transactions and balances have been eliminated.

Fiscal Year

Our fiscal year ends on the Sunday closest to January 31, based on a 52 or 53-week year. Fiscal 2022, a 52-week year, ended on January 29, 2023; Fiscal 2021, a 52-week year, ended on January 30, 2022; and Fiscal 2020, a 52-week year, ended on January 31, 2021.

Use of Estimates

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures of contingent assets and liabilities. These estimates and assumptions are evaluated on an ongoing basis and are based on historical experience and various other factors that we believe to be reasonable under the circumstances. Actual results could differ from these estimates.

Cash Equivalents

Cash equivalents include highly liquid investments with an original maturity of three months or less. As of January 29, 2023, we were invested primarily in interest-bearing demand deposit accounts and money market funds. Book cash overdrafts issued, but not yet presented to the bank for payment, are reclassified to accounts payable.

Accounts Receivable and Allowance for Doubtful Accounts

Accounts receivable are stated at their carrying values, net of an allowance for doubtful accounts. Accounts receivable consist primarily of credit card, franchisee and landlord receivables for which collectability is reasonably assured. Receivables are evaluated for collectability on a regular basis and an allowance for doubtful accounts is recorded, if necessary. Our allowance for doubtful accounts was not material to our financial statements as of January 29, 2023 and January 30, 2022.

Merchandise Inventories

Merchandise inventories, net of an allowance for shrinkage and obsolescence, are stated at the lower of cost (weighted average method) or net realizable value. To determine if the value of our inventory should be reduced below cost, we consider current and anticipated demand, customer preferences and age of the merchandise. We reserve for obsolescence based on historical trends of inventory sold below cost and specific identification.

Reserves for shrinkage are estimated and recorded throughout the year based on historical shrinkage results, cycle count results within our distribution centers, expectations of future shrinkage and current inventory levels. Actual shrinkage is recorded at year-end based on the results of our cycle counts and physical inventory counts and can vary from our estimates due to such factors as changes in operations, the mix of our inventory (which ranges from large furniture to small tabletop items) and execution against loss prevention initiatives in our stores, distribution facilities, off-site storage locations, and with our third-party warehouse and transportation providers. Accordingly, there is no material shrinkage reserve at year-end. Historically, actual shrinkage has not differed materially from our estimates.

Our obsolescence and shrinkage reserve calculations contain estimates that require management to make assumptions and to apply judgment regarding a number of factors, including market conditions, the selling environment, historical results and current inventory trends. If actual obsolescence or shrinkage estimates change from our original estimate, we will adjust our reserves accordingly throughout the year. As of January 29, 2023, and January 30, 2022, our inventory obsolescence reserves were $24.7 million and $14.0 million, respectively.

Long-lived Assets

Property and equipment is stated at cost. Depreciation is computed using the straight-line method over the following estimated useful lives of the assets:

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Leasehold improvementsShorter of estimated useful life or lease term (generally 5 – 22 years)
Fixtures and equipment2 – 20 years
Buildings and building improvements10 – 40 years
Capitalized software2 – 10 years

We review the carrying value of all long-lived assets for impairment, primarily at an individual store level, whenever events or changes in circumstances indicate that the carrying value of an asset or asset group may not be recoverable. Our impairment analyses determine whether projected cash flows from operations are sufficient to recover the carrying value of these assets. The asset group is comprised of both property and equipment and operating lease right-of-use assets. Impairment may result when the carrying value of the asset or asset group exceeds the estimated undiscounted future cash flows over its remaining useful life. For asset impairment, our estimate of undiscounted future cash flows over the lease term is based upon our experience, the historical operations and estimates of future profitability and economic conditions. The estimates of future profitability and economic conditions require estimating such factors as sales growth, gross margin, employment costs, lease escalations, inflation and the overall economics of the retail industry, and are therefore subject to variability and difficult to predict. For right-of-use assets, we determine the fair value of the assets by using estimated market rental rates. These estimates can be affected by factors such as future results, real estate supply and demand, closure plans, and economic conditions that can be difficult to predict. Actual future results may differ from those estimates. If a long-lived asset is found to be impaired, the amount recognized for impairment is equal to the excess of the asset or asset group’s net carrying value over its estimated fair value. We measure property and equipment at fair value on a nonrecurring basis using Level 3 inputs as defined in the fair value hierarchy (see Note M to our Consolidated Financial Statements). We measure right-of-use assets at fair value on a nonrecurring basis using Level 2 inputs, primarily market rental rates, that are corroborated by market data. Where Level 2 inputs are not readily available, we use Level 3 inputs. Fair value of these long-lived assets is based on the present value of estimated future cash flows using a discount rate commensurate with the risk.

During fiscal 2022, we recognized impairment charges of $3.3 million related to the impairment of property and equipment and $2.6 million related to the impairment of operating lease right-of-use assets, due to lower projected revenues and fair market rental values resulting from underperforming stores in Australia, and we also recognized impairment charges of $9.7 million related to the impairment of property and equipment associated with Aperture, a division of our Outward, Inc. subsidiary, due to these assets not being recoverable in light of projected future cash flows, all of which is recognized within selling, general and administrative ("SG&A") expenses. During fiscal 2021, no impairment charges were recognized. During fiscal 2020, we recognized asset impairment charges of approximately $19.2 million related to property and equipment and $7.9 million related to right-of use assets for our retail stores, which is recognized within SG&A expenses.

Leases

We lease store locations, distribution and manufacturing facilities, corporate facilities, customer care centers and certain equipment for our U.S. and foreign operations with initial terms generally ranging from 2 to 22 years. We determine whether an arrangement is or contains a lease at inception by evaluating potential lease agreements including services and operating agreements to determine whether an identified asset exists that we control over the term of the arrangement. Lease commencement is determined to be when the lessor provides us access to, and the right to control, the identified asset.

The rental payments for our leases are typically structured as either fixed or variable payments. Our fixed rent payments include: stated minimum rent and stated minimum rent with stated increases. We consider lease payments that cannot be predicted with reasonable certainty upon lease commencement to be variable lease payments, which are recorded as incurred each period and are excluded from our calculation of lease liabilities. Our variable rent payments include: rent increases based on a future index; rent based on a percentage of store sales; payments made for pass-through costs for property taxes, insurance, utilities and common area maintenance; and rent based on a percentage of store sales if a specified store sales threshold or contractual obligation of the landlord has not been met.

Upon lease commencement, we recognize a right-of use asset and a corresponding lease liability measured at the present value of the fixed future minimum lease payments. We have elected the practical expedient to not separate lease and non-lease components. Therefore, lease payments included in the measurement of the lease liability include all fixed payments in the lease arrangement. We record a right-of-use asset for an amount equal to the lease liability, increased for any prepaid lease costs and initial direct costs and reduced by any lease incentives. We remeasure the lease liability and right-of-use asset when a remeasurement event occurs.

Many of our leases contain renewal and early termination options. The option periods are generally not included in the lease term used to measure our lease liabilities and right-of-use assets upon commencement, as we do not believe the exercise of these options to be reasonably certain. We remeasure the lease liability and right-of-use asset once we are reasonably certain to exercise a renewal or an early termination option.

Our leases generally do not provide information about the rate implicit in the lease. Therefore, we utilize an incremental borrowing rate to calculate the present value of our future lease obligations. The incremental borrowing rate represents the rate of interest we would have to pay on a collateralized borrowing, for an amount equal to the lease payments, over a similar term and in a similar economic environment. We use judgment in determining our incremental borrowing rate, which is applied to each lease based on the

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lease term. An increase or decrease in the incremental borrowing rate applied would impact the value of our right-of-use assets and lease liabilities.

We use judgment in determining lease classification, including our determination of the economic life and the fair market value of the identified asset. The fair market value of the identified asset is generally estimated based on comparable market data provided by third-party sources. All of our leases are currently classified as operating leases.

Goodwill

Goodwill is initially recorded as of the acquisition date and is measured as any excess of the purchase price over the estimated fair value of the identifiable net assets acquired. Goodwill is not amortized, but rather is subject to impairment testing annually (on the first day of the fourth quarter), or between annual tests whenever events or changes in circumstances indicate that the fair value of a reporting unit may be below its carrying amount. We first perform a qualitative assessment to evaluate goodwill for potential impairment. If based on that assessment it is more likely than not that the fair value of the reporting unit is below its carrying value, a quantitative impairment test is necessary. The quantitative impairment test requires determining the fair value of the reporting unit. We use the income approach, whereby we calculate the fair value based on the present value of estimated future cash flows, using a discount rate that approximates the reporting unit's weighted average cost of capital. The process of evaluating the potential impairment of goodwill is subjective and requires significant estimates and assumptions about the future such as sales growth, gross margins, employment costs, capital expenditures, inflation and future economic and market conditions. We measure the fair value using Level 3 inputs as defined in the fair value hierarchy (see Note M to our Consolidated Financial Statements). Actual future results may differ from those estimates. If the carrying value of the reporting unit’s assets and liabilities, including goodwill, exceeds its fair value, impairment is recorded for the excess, not to exceed the total amount of goodwill allocated to the reporting unit.

As of January 29, 2023 and January 30, 2022, we had goodwill of $77.3 million and $85.4 million, respectively, primarily related to our fiscal 2017 acquisition of Outward and our fiscal 2011 acquisition of Rejuvenation, Inc. In fiscal 2022, we performed our annual quantitative assessment of goodwill impairment for the Aperture reporting unit, a division of our Outward, Inc. subsidiary, using the income approach. We fully impaired the goodwill related to the Aperture reporting unit due to these assets not being recoverable in light of projected future cash flows, resulting in goodwill impairment charges of $8.0 million. For all other reporting units, we concluded that the fair value exceeded their carrying values and no further impairment testing of goodwill was performed. In fiscal 2021 and fiscal 2020, we performed our annual assessment of goodwill impairment and concluded that the fair value of each of our reporting units exceeded its carrying value. Accordingly, no further impairment testing of goodwill was performed. We did not recognize any goodwill impairment in fiscal 2021 or fiscal 2020.

Self-Insured Liabilities

We are primarily self-insured for workers’ compensation, employee health benefits, product and other general liability claims. We record self-insurance liability reserves based on claims filed, including the development of those claims, and an estimate of claims incurred but not yet reported, based on an actuarial analysis of historical claims data. Factors affecting these estimates include future inflation rates, changes in severity, benefit level changes, medical costs and claim settlement patterns. Should a different number of claims occur compared to what was estimated, or costs of the claims increase or decrease beyond what was anticipated, reserves may need to be adjusted accordingly. Self-insurance reserves for workers’ compensation, employee health benefits, product and other general liability claims were $26.8 million and $25.5 million as of January 29, 2023 and January 30, 2022, respectively.

Fair Value of Financial Instruments

The carrying values of cash and cash equivalents, accounts receivable, accounts payable and debt approximate their estimated fair values. We use derivative financial instruments to hedge against foreign currency exchange rate fluctuations. The assets or liabilities associated with our derivative financial instruments are recorded at fair value in either other current or long-term assets or other current or long-term liabilities. The fair value of our foreign currency derivative instruments is measured using the income approach, whereby we use observable market data at the measurement date and standard valuation techniques to convert future amounts to a single present value amount. These observable inputs include spot rates, forward rates, interest rates and credit derivative market rates (see Notes L and M for additional information).

Revenue from Merchandise Sales

Revenues from the sale of our merchandise through our e-commerce channel, at our retail stores as well as to our business-to-business customers and franchisees are, in each case, recognized at a point in time when control of merchandise is transferred to the customer. Merchandise can either be picked up in our stores, or delivered to the customer. For merchandise picked up in the store, control is transferred at the time of the sale to the customer. For merchandise delivered to the customer, control is transferred either when delivery has been completed, or when we have a present right to payment which, for certain merchandise, occurs upon conveyance of the merchandise to the carrier for delivery. We exclude from revenue any taxes assessed by governmental authorities, including value-added and other sales-related taxes, that are imposed on and are concurrent with revenue-generating activities. Our payment terms are primarily at the point of sale for merchandise sales and for most services. We have elected to account for shipping and handling as fulfillment activities, and not as a separate performance obligation.

Revenue from the sale of merchandise is reported net of sales returns. We estimate future returns based on historical return trends together with current product sales performance. As of January 29, 2023 and January 30, 2022, we recorded a liability for expected

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sales returns of approximately $61.9 million and $47.2 million within other current liabilities and a corresponding asset for the expected net realizable value of the merchandise inventory to be returned of approximately $19.5 million and $14.3 million within other current assets in our Consolidated Balance Sheet.

Gift Card and Other Deferred Revenue

We defer revenue and record a liability when cash payments are received in advance of satisfying performance obligations, primarily associated with our merchandise sales, stored-value cards, customer loyalty programs, and incentives received from credit card issuers.

We issue stored-value cards that may be redeemed on future merchandise purchases. Our stored-value cards have no expiration dates. Revenue from stored-value cards is recognized at a point in time upon redemption of the card and as control of the merchandise is transferred to the customer. Breakage is recognized in a manner consistent with our historical redemption patterns over the estimated period of redemption of our cards of approximately four years, the majority of which is recognized within one year of the card issuance. Breakage revenue is not material to our Consolidated Financial Statements.

We have customer loyalty programs, which allow members to earn points for each qualifying purchase. Customers can earn points through spend on both our private label and co-branded credit cards, or can earn points as part of our non-credit card related loyalty program. Points earned through both loyalty programs enable members to receive certificates that may be redeemed on future merchandise purchases. This customer option is a material right and, accordingly, represents a separate performance obligation to the customer. The allocated consideration for the points or certificates earned by our loyalty program members is deferred based on the standalone selling price of the points and recorded within gift card and other deferred revenue within our Consolidated Balance Sheet. The measurement of standalone selling prices takes into consideration the discount the customer would receive in a separate transaction for the delivered item, as well as our estimate of certificates expected to be issued and redeemed, based on historical patterns. This measurement is applied to our portfolio of performance obligations for points or certificates earned, as all obligations have similar economic characteristics. We believe the impact to our Consolidated Financial Statements would not be materially different if this measurement was applied to each individual performance obligation. Revenue is recognized for these performance obligations at a point in time when certificates are redeemed by the customer. These obligations relate to contracts with terms less than one year, as our certificates generally expire within six months from issuance.

We enter into agreements with credit card issuers in connection with our private label and co-branded credit cards, whereby we receive cash incentives in exchange for promised services, such as licensing our brand names and marketing the credit card program to customers. These separate non-loyalty program related services promised under these agreements are interrelated and are thus considered a single performance obligation. Revenue is recognized over time as we transfer promised services throughout the contract term.

As of January 29, 2023 and January 30, 2022, we had recorded $482.2 million and $451.3 million, respectively, for gift card and other deferred revenue in our Consolidated Balance Sheet, substantially all of which is expected to be recognized into revenue within the next 12 months.

Vendor Allowances

We receive allowances or credits from certain vendors for volume and other rebates. We treat such rebates as an offset to the cost of the product or services provided at the time the expense is recorded. These allowances and credits received are recorded in both cost of goods sold and in SG&A expenses.

Cost of Goods Sold

Cost of goods sold includes cost of goods, occupancy expenses and shipping costs. Cost of goods consists of cost of merchandise, inbound freight expenses, freight-to-store expenses and other inventory-related costs such as replacements, damages, obsolescence and shrinkage. Occupancy expenses consist of rent, other occupancy costs (including property taxes, common area maintenance and utilities) and depreciation. Shipping costs consist of third-party delivery services and shipping materials.

Selling, General and Administrative Expenses

SG&A expenses consist of non-occupancy-related costs associated with our retail stores, distribution facilities, customer care centers, supply chain operations (buying, receiving and inspection), and corporate administrative functions. These costs include employment, advertising, third-party credit card processing and other general expenses.

Stock-Based Compensation

We account for stock-based compensation arrangements by measuring and recognizing compensation expense for all stock-based awards using a fair value-based method. Restricted stock units are valued using the closing price of our stock on the date prior to the date of grant. The fair value of each stock-based award is amortized over the requisite service period, net of estimated forfeitures. We estimate the forfeiture rate based on an analysis of historical experience as well as expected future trends.

Advertising Expenses

Advertising expenses consist of media and production costs related to digital advertising, catalog mailings and other direct marketing activities. All advertising costs are expensed as incurred, or upon the release of the initial advertisement.

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Total advertising expenses (including digital advertising, catalog advertising and other advertising costs) were approximately $581.1 million, $618.5 million, and $326.0 million in fiscal 2022, fiscal 2021 and fiscal 2020, respectively.

Foreign Currency Translation

Some of our foreign operations have a functional currency other than the U.S. dollar. Assets and liabilities are translated into U.S. dollars using the current exchange rates in effect at the balance sheet date, while revenues and expenses are translated at the average exchange rates during the period. The resulting translation adjustments are recorded as other comprehensive income within stockholders’ equity. Foreign currency exchange gains and losses are recorded in SG&A expenses, except for those discussed in Note L.

Earnings Per Share

Basic earnings per share is computed as net earnings divided by the weighted average number of common shares outstanding for the period. Diluted earnings per share is computed as net earnings divided by the weighted average number of common shares outstanding plus common stock equivalents for the period. Common stock equivalents consist of shares subject to stock-based awards with exercise prices less than or equal to the average market price of our common stock for the period, to the extent their inclusion would be dilutive.

Income Taxes

Income taxes are accounted for using the asset and liability method. Under this method, deferred income taxes arise from temporary differences between the tax basis of assets and liabilities and their reported amounts in our Consolidated Financial Statements. We record reserves for our estimates of the additional income tax liability that is more likely than not to result from the ultimate resolution of foreign and domestic tax examinations. At any point in time, many tax years are subject to examination by various taxing jurisdictions. The results of these audits and negotiations with taxing authorities may affect the ultimate settlement of these issues. We review and update the estimates used in the accrual for uncertain tax positions as more definitive information becomes available from taxing authorities, upon completion of tax examination, upon expiration of statutes of limitation, or upon occurrence of other events.

In order to compute income tax on an interim basis, we estimate what our effective tax rate will be for the full fiscal year and adjust these estimates throughout the year as necessary. Adjustments to our income tax provision due to changes in our estimated effective tax rate are recorded in the interim period in which the change occurs. The tax expense (or benefit) related to items other than ordinary income is individually computed and recognized when the items occur. Our effective tax rate in a given financial statement period may be materially impacted by changes in the mix and level of our earnings in various taxing jurisdictions or changes in tax law.

Recently Issued Accounting Pronouncements

In March 2020, January 2021 and December 2022, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848), ASU-2021-01, Reference Rate Reform: Scope, ASU-2022-06, Reference Rate Reform (Topic 848), Deferral of the Sunset Date of Topic 848, respectively. Together, the ASUs are intended to ease the potential accounting and financial reporting burden of reference rate reform, including the expected market transition from the London Interbank Offered Rate (LIBOR) and other interbank offered rates to alternative reference rates. The guidance provides optional expedients and scope exceptions for transactions if certain criteria are met. These transactions include contract modifications, hedge accounting, and the sale or transfer of debt securities classified as held-to-maturity. We may elect to apply the provisions of the new standard prospectively through December 31, 2024. Unlike other topics, the provisions of this update are only available until December 31, 2024, by which time the reference rate replacement activity is expected to be completed. We have yet to elect an adoption date, but do not believe any adoption would have a material impact on our financial condition, results of operations or cash flows.

Note B: Property and Equipment

Property and equipment consists of the following:

As of
(In thousands)January 29, 2023January 30, 2022
Capitalized Software$1,097,914$980,876
Leasehold improvements895,732882,320
Fixtures and equipment933,922863,353
Land and buildings180,923179,843
Corporate systems projects in progress49,44457,604
Construction in progress 161,45519,112
Total3,219,3902,983,108
Accumulated depreciation(2,154,009)(2,062,335)
Property and equipment, net$1,065,381$920,773

1 Construction in progress primarily consists of fixtures and equipment and leasehold improvements related to new, expanded or remodeled distribution centers and retail stores where construction had not been completed as of year-end.

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Note C: Borrowing Arrangements

Credit Facility

We have a credit facility (the "Credit Facility") which provides for a $500 million unsecured revolving line of credit (the “Revolver”). Our Revolver may be used to borrow revolving loans or to request the issuance of letters of credit. We may, upon notice to the administrative agent, request existing or new lenders, at such lenders’ option, to increase the Revolver by up to $250 million to provide for a total of $750 million of unsecured revolving credit.

During fiscal 2022 and fiscal 2021, we had no borrowings under our Revolver. Additionally, as of January 29, 2023, issued but undrawn standby letters of credit of $11.2 million were outstanding under our Revolver. The standby letters of credit were primarily issued to secure the liabilities associated with workers’ compensation and other insurance programs. Our Revolver matures on September 30, 2026, at which time all outstanding borrowings must be repaid and all outstanding letters of credit must be cash collateralized. We may elect to extend the maturity date, subject to lender approval.

Currently, the interest rate applicable to the Revolver is variable and may be elected by us as: (i) the LIBOR plus an applicable margin based on our leverage ratio ranging from 0.91% to 1.775% or (ii) a base rate as defined in the Credit Facility, plus an applicable margin based on our leverage ratio ranging from 0% to 0.775%. However, as a result of the future cessation of LIBOR, our interest rate will change in fiscal 2023 in accordance with the Credit Facility. On the earliest of (i) the date that LIBOR rates permanently or indefinitely cease to be provided, (ii) June 30, 2023 or (iii) the early opt-in effective date which is determined by us, the replacement benchmark rate will be determined.

Our Credit Facility contains certain restrictive loan covenants, including, among others, a financial covenant requiring a maximum leverage ratio (funded debt adjusted for operating lease liabilities to earnings before interest, income tax, depreciation, amortization and rent expense), and covenants limiting our ability to incur indebtedness, grant liens, make acquisitions, merge or consolidate, and dispose of assets. As of January 29, 2023, we were in compliance with our financial covenants under our credit facilities and, based on our current projections, we expect to remain in compliance throughout the next 12 months.

Letter of Credit Facilities

We have three unsecured letter of credit reimbursement facilities for a total of $35 million. Our letter of credit facilities contain covenants that are consistent with our Credit Facility. Interest on unreimbursed amounts under our letter of credit facilities accrues at a base rate as defined in the credit facility, plus an applicable margin based on our leverage ratio. As of January 29, 2023, the aggregate amount outstanding under our letter of credit facilities was $0.5 million, which represents only a future commitment to fund inventory purchases to which we had not taken legal title. On August 19, 2022, we renewed all three of our letter of credit facilities on substantially similar terms. Two of the letter of credit facilities totaling $30 million mature on August 19, 2023, and the latest expiration date possible for future letters of credit issued under these facilities is January 16, 2024. One of the letter of credit facilities totaling $5 million matures on September 30, 2026, which is also the latest expiration date possible for future letters of credit issued under the facility.

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Note D: Income Taxes

The components of earnings before income taxes, by tax jurisdiction, are as follows:

For the Fiscal Year Ended
(In thousands)January 29, 2023January 30, 2022January 31, 2021
United States$1,331,492$1,280,438$773,317
Foreign169,190170,813121,149
Total$1,500,682$1,451,251$894,466

The provision for income taxes consists of the following:

For the Fiscal Year Ended
(In thousands)January 29, 2023January 30, 2022January 31, 2021
Current
Federal$299,015$234,638$171,821
State71,12061,05639,498
Foreign26,46626,68515,494
Total Current$396,601$322,379$226,813
Deferred
Federal$(17,293)$5,896$(7,575)
State(3,292)(741)(5,997)
Foreign(3,238)(2,620)511
Total Deferred$(23,823)$2,535$(13,061)
Total provision$372,778$324,914$213,752

Since the Tax Cuts and Jobs Act of 2017, we have elected not to provide for income taxes with respect to the earnings of Canada after fiscal 2017. In the second quarter of fiscal 2022, we assessed the overall forecasted cash needs and financial position of our foreign subsidiaries, and management decided to no longer assert its intent to indefinitely reinvest undistributed earnings in Canada. As a result of this change in assertion, we recorded $2.4 million of tax expense mainly related to Canadian withholding taxes.

A reconciliation of income taxes at the federal statutory corporate rate to the effective rate is as follows:

For the Fiscal Year Ended
(In thousands)January 29, 2023January 30, 2022January 31, 2021
Federal income taxes at the statutory rate21.0%21.0%21.0%
State income tax rate4.24.13.9
Officer’s compensation under Sec.162(m)1.42.01.1
Change in uncertain tax positions0.3(0.5)0.2
Deferred true up0.1(0.1)(0.6)
Rate differential(0.7)(0.6)(1.1)
Credits(0.2)(0.2)(0.2)
Stock-based compensation(1.7)(2.9)(0.2)
Other0.4(0.4)(0.2)
Total24.8%22.4%23.9%

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Significant components of our deferred income tax accounts are as follows:

As of
(In thousands)January 29, 2023January 30, 2022
Deferred tax assets (liabilities)
Operating lease liabilities$359,001$321,649
Merchandise inventories32,33823,513
Gift cards24,63221,519
Accrued liabilities22,35617,919
Compensation18,96027,069
Stock-based compensation14,30811,879
Executive deferred compensation9,60510,476
State taxes8,0847,362
Loyalty rewards3,7345,246
State net operating loss2,4462,552
Operating lease right-of-use assets(321,646)(285,764)
Property and equipment(65,039)(76,643)
Deferred lease incentives(22,400)(28,808)
Other(4,756)57
Valuation allowance(2,635)(2,760)
Total deferred tax assets, net$78,988$55,266

We had net state operating loss carry-forwards as of January 29, 2023. A valuation allowance has been provided against certain state net operating loss carry-forwards, as we do not expect to fully utilize the losses in future years.

The following table summarizes the activity related to our gross unrecognized tax benefits:

For the Fiscal Year Ended
(In thousands)January 29, 2023January 30, 2022January 31, 2021
Beginning Balance$33,612$38,696$36,638
Increases related to current year tax positions8,1698,5734,593
Increases for tax positions for prior years8071,738848
Decrease for tax positions for prior years(2,237)(82)(437)
Lapse in statute of limitations(3,283)(15,313)(2,946)
Ending Balance$37,068$33,612$38,696

As of January 29, 2023, we had $37.1 million of gross unrecognized tax benefits, of which $31.0 million would, if recognized, affect the effective tax rate.

We accrue interest and penalties related to unrecognized tax benefits in the provision for income taxes. As of January 29, 2023 and January 30, 2022, our accruals for the payment of interest and penalties totaled $6.1 million and $5.7 million, respectively.

Due to the potential resolution of tax issues, it is reasonably possible that the balance of our gross unrecognized tax benefits could decrease within the next twelve months by a range of $0 to $6.2 million.

We file income tax returns in the U.S. and foreign jurisdictions. We are subject to examination by the tax authorities in these jurisdictions. Our U.S. federal taxable years for which the statute of limitations has not expired are fiscal years 2018 to 2022. Substantially all material states, local and foreign jurisdictions’ statutes of limitations are closed for taxable years prior to 2019.

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Note E: Leases

The components of our lease costs are as follows:

For the Fiscal Year Ended
(In thousands)January 29, 2023January 30, 2022
Operating lease costs$275,086$256,924
Variable lease costs138,155127,784
Total lease costs$413,241$384,708

Sublease income and short-term lease costs were not material to us for fiscal 2022 or fiscal 2021.

Supplemental cash flow information related to our leases are as follows:

For the Fiscal Year Ended
(In thousands)January 29, 2023January 30, 2022
Cash paid for amounts included in the measurement of operating lease liabilities$296,053$279,005
Net additions to right-of-use assets$389,494$268,143

Additional information related to our leases is as follows:

For the Fiscal Year Ended
January 29, 2023January 30, 2022
Weighted average remaining lease term (years)6.97.0
Weighted average incremental borrowing rate3.4%3.2%

As of January 29, 2023, the future minimum lease payments under our operating lease liabilities are as follows:

(In thousands)
Fiscal 2023$308,272
Fiscal 2024275,043
Fiscal 2025244,068
Fiscal 2026209,178
Fiscal 2027173,054
Fiscal 2028 and thereafter457,271
Total lease payments1,666,886
Less: interest(223,228)
Total operating lease liabilities1,443,658
Less: current operating lease liabilities(231,965)
Total non-current operating lease liabilities$1,211,693

We have also entered into agreements to lease additional distribution facilities and retail spaces, which will commence in fiscal 2023. Accordingly, future minimum lease payments under these agreements are not included in the table above.

Memphis-Based Distribution Facility

We have entered into an agreement with a partnership comprised of the estate of W. Howard Lester, our former Chairman of the Board and Chief Executive Officer, and the estate of James A. McMahan, a former Director Emeritus and significant stockholder and two unrelated parties to lease a distribution facility in Memphis, Tennessee through January 31, 2024. We made annual rental payments of approximately $2.3 million, $2.1 million, and $1.5 million plus applicable taxes, insurance and maintenance expenses in fiscal 2022, fiscal 2021 and fiscal 2020, respectively.

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Note F: Earnings Per Share

Basic earnings per share is computed as net earnings divided by the weighted average number of common shares outstanding for the period. Diluted earnings per share is computed as net earnings divided by the weighted average number of common shares outstanding and common stock equivalents outstanding for the period. Common stock equivalents consist of shares subject to stock-based awards to the extent their inclusion would be dilutive.

The following is a reconciliation of net earnings and the number of shares used in the basic and diluted earnings per share computations:

(In thousands, except per share amounts)Net EarningsWeighted Average SharesEarnings Per Share
Fiscal 2022
Basic$1,127,90468,021$16.58
Effect of dilutive stock-based awards1,079
Diluted$1,127,90469,100$16.32
Fiscal 2021
Basic$1,126,33774,272$15.17
Effect of dilutive stock-based awards2,082
Diluted$1,126,33776,354$14.75
Fiscal 2020
Basic$680,71477,260$8.81
Effect of dilutive stock-based awards1,795
Diluted$680,71479,055$8.61

The effect of anti-dilutive stock-based awards was not material for fiscal 2022, fiscal 2021 and fiscal 2020, respectively.

Note G: Stock-Based Compensation

Equity Award Programs

Our Amended and Restated 2001 Long-Term Incentive Plan (the “Plan”) provides for grants of incentive stock options, nonqualified stock options, stock-settled stock appreciation rights (collectively, “option awards”), restricted stock awards, restricted stock units (including those that are performance-based), deferred stock awards (collectively, “stock awards”) and dividend equivalents up to an aggregate of approximately 42.7 million shares. As of January 29, 2023, there were approximately 6.7 million shares available for future grant. Awards may be granted under the Plan to officers, employees and non-employee members of the Board of Directors of the Company (the “Board”) or any parent or subsidiary. Shares issued as a result of award exercises or releases are primarily funded with the issuance of new shares.

Stock Awards

Annual grants of stock awards are limited to 1.0 million shares on a per person basis. Stock awards granted to employees generally vest evenly over a period of four years for service-based awards. Certain performance-based awards, which have variable payout conditions based on predetermined financial targets, generally vest three years from the date of grant. Certain stock awards and other agreements contain vesting acceleration clauses resulting from events including, but not limited to, retirement, disability, death, merger or a similar corporate event. Stock awards granted to non-employee Board members generally vest in one year. Non-employee Board members automatically receive stock awards on the date of their initial election to the Board and annually thereafter on the date of the annual meeting of stockholders (so long as they continue to serve as a non-employee Board member).

Stock-Based Compensation Expense

During fiscal 2022, fiscal 2021 and fiscal 2020, we recognized total stock-based compensation expense, as a component of SG&A expenses, of $90.3 million, $95.2 million, and $73.2 million, respectively. As of January 29, 2023, there was $121.6 million of unrecognized stock-based compensation expense (net of estimated forfeitures), which we expect to recognize on a straight-line basis over a weighted average remaining service period of approximately two years. At each reporting period, all compensation expense attributable to vested awards has been fully recognized.

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Restricted Stock Units

The following table summarizes our restricted stock unit activity during fiscal 2022:

SharesWeighted Average Grant Date Fair ValueWeighted Average Contractual Term Remaining (Years)Intrinsic Value 1
Balance at January 30, 20222,384,032$83.49
Granted538,214156.64
Granted, with vesting subject to performance conditions131,774162.28
Released 2(995,544)66.61
Cancelled(376,789)107.79
Balance at January 29, 20231,681,687$117.622.74$213,019,000
Vested plus expected to vest at January 29, 20231,547,297$121.243.19$195,996,000

1**Intrinsic value for outstanding and unvested restricted stock units is based on the market value of our common stock on the last business day of the fiscal year (or $126.67).

2**Excludes 224,028 incremental shares released due to achievement of performance conditions above target.

The following table summarizes additional information about restricted stock units:

For the Fiscal Year Ended
January 29, 2023January 30, 2022January 31, 2021
Weighted average grant date fair value per share of awards granted$157.75$172.46$59.51
Intrinsic value of awards released1 2$180,450,000$234,293,000$74,853,000

1**Intrinsic value for releases is based on the market value on the date of release.

2**Includes 224,028 incremental shares released due to achievement of performance conditions above target.

Tax Benefit

We record excess tax benefits and deficiencies resulting from the settlement of stock-based awards as a benefit or expense within income taxes in the period in which they occur. During fiscal 2022, fiscal 2021, and fiscal 2020, the current tax benefit related to stock-based awards totaled $24.8 million, $36.4 million, and $15.7 million, respectively.

Note H: Williams-Sonoma, Inc. 401(k) Plan and Other Employee Benefits

We have a defined contribution retirement plan, the Williams-Sonoma, Inc. 401(k) Plan (the “401(k) Plan”), which is intended to be qualified under Internal Revenue Code sections 401(a), 401(k), 401(m) and 4975(e)(7). The 401(k) Plan permits eligible employees to make salary deferral contributions up to 75% of their eligible compensation each pay period. Employees designate the funds in which their contributions are invested. Each participant may choose to have their salary deferral contributions and earnings thereon invested in one or more investment funds, including our company stock fund.

Our matching contribution is equal to 50% of each participant’s salary deferral contribution, taking into account only those contributions that do not exceed 6% of the participant’s eligible pay for the pay period. Each participant’s matching contribution is earned on a semi-annual basis with respect to eligible salary deferrals for those participants that are employed with us on June 30th or December 31st of the year in which the deferrals are made. Each participant starts earning matching contributions beginning the first calendar quarter following one year of service. Prior to fiscal 2022, for the first five years of the participant’s employment, all matching contributions vested at the rate of 20% per year of service, measuring service from the participant’s hire date. Thereafter, all matching contributions were vested immediately. Effective July 2022, all matching contributions become vested 100% after one year of service. Our contributions to the plan were $11.4 million, $11.3 million, and $10.0 million in fiscal 2022, fiscal 2021 and fiscal 2020, respectively.

The 401(k) Plan consists of two parts: a profit sharing plan portion and a stock bonus plan/employee stock ownership plan (the “ESOP”). The ESOP portion is the portion that is invested in the Williams-Sonoma, Inc. Stock Fund. The profit sharing and ESOP components of the 401(k) Plan are considered a single plan under Internal Revenue Code section 414(l).

We also have a nonqualified executive deferred compensation plan that provides supplemental retirement income benefits for a select group of management. This plan permits eligible employees to make salary and bonus deferrals that are 100% vested. We have an unsecured obligation to pay in the future the value of the deferred compensation adjusted to reflect the performance, whether positive or negative, of selected investment measurement options chosen by each participant during the deferral period. As of January 29, 2023 and January 30, 2022, $38.8 million and $42.3 million, respectively, is included in other long-term liabilities related to these deferred compensation obligations. Additionally, we have purchased life insurance policies on certain participants to potentially offset these

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unsecured obligations. The cash surrender value of these policies was $38.4 million and $46.3 million as of January 29, 2023 and January 30, 2022, respectively, and is included in other long-term assets, net.

Note I: Commitments and Contingencies

We are involved in lawsuits, claims and proceedings incident to the ordinary course of our business. These disputes, which are not currently material, are increasing in number as our business expands and our company grows. We review the need for any loss contingency reserves and establish reserves when, in the opinion of management, it is probable that a matter would result in liability, and the amount of loss, if any, can be reasonably estimated. In view of the inherent difficulty of predicting the outcome of these matters, it may not be possible to determine whether any loss is probable or to reasonably estimate the amount of the loss until the case is close to resolution, in which case no reserve is established until that time. Any claims against us, whether meritorious or not, could result in costly litigation, require significant amounts of management time and result in the diversion of significant operational resources. The results of these lawsuits, claims and proceedings cannot be predicted with certainty. However, we believe that the ultimate resolution of these current matters will not have a material adverse effect on our Consolidated Financial Statements taken as a whole.

Note J: Stock Repurchase Program and Dividends

Stock Repurchase Program

During fiscal 2022, we repurchased 6,423,643 shares of our common stock at an average cost of $137.00 per share and a total cost of $880.0 million under our $1.5 billion stock repurchase program approved in March 2022. As of January 29, 2023, there was $690.0 million remaining under our current stock repurchase program. In March 2023, our Board of Directors authorized a new stock repurchase program for $1 billion, which replaced our existing program. As of January 29, 2023, we held treasury stock of $0.7 million that represents the cost of shares available for issuance intended to satisfy future stock-based award settlements in certain foreign jurisdictions.

During fiscal 2021, we repurchased 5,102,624 shares of our common stock at an average cost of $176.27 per share and a total cost of $899.4 million. During fiscal 2020, we repurchased 1,496,100 shares of our common stock at an average cost of $100.26 per share and a total cost of $150.0 million.

Stock repurchases under our program may be made through open market and privately negotiated transactions at times and in such amounts as management deems appropriate. The timing and actual number of shares repurchased will depend on a variety of factors including price, corporate and regulatory requirements, capital availability and other market conditions.

Dividends

Total cash dividends declared in fiscal 2022, fiscal 2021 and fiscal 2020, were approximately $216.3 million, or $3.12 per common share, $199.4 million, or $2.60 per common share and $163.3 million, or $2.02 per common share, respectively. In March 2023, our Board of Directors authorized a 15% increase in our quarterly cash dividend, from $0.78 to $0.90 per common share, subject to capital availability. Our quarterly cash dividend may be limited or terminated at any time.

Note K: Segment Reporting

We identify our operating segments according to how our business activities are managed and evaluated. Each of our brands are operating segments. Because they share similar economic and other qualitative characteristics, we have aggregated our operating segments into a single reportable segment.

The following table summarizes our net revenues by brand for fiscal 2022, fiscal 2021 and fiscal 2020.

For the Fiscal Year Ended 1
(In thousands)January 29, 2023January 30, 2022January 31, 2021
Pottery Barn$3,555,521$3,120,687$2,526,241
West Elm2,278,1312,234,5481,682,254
Williams Sonoma1,286,6511,345,8511,242,271
Pottery Barn Kids and Teen1,132,9371,139,8931,042,531
Other 2421,177404,957289,892
Total 3$8,674,417$8,245,936$6,783,189

1**Includes business-to-business net revenues within each brand.

2**Primarily consists of net revenues from Rejuvenation, our international franchise operations and Mark and Graham.

3**Includes net revenues related to our international operations (including our operations in Canada, Australia, the United Kingdom and our franchise businesses) of approximately $407.9 million, $426.7 million and $345.7 million for fiscal 2022, fiscal 2021 and fiscal 2020, respectively.

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Long-lived assets by geographic location, which excludes deferred income taxes, goodwill and intangible assets, are as follows:

(In thousands)January 29, 2023January 30, 2022
U.S.$2,361,279$2,020,438
International96,038129,444
Total$2,457,317$2,149,882

Note L: Derivative Financial Instruments

We have retail and e-commerce businesses in Canada, Australia and the United Kingdom, and operations throughout Asia and Europe, which expose us to market risk associated with foreign currency exchange rate fluctuations. Substantially all of our purchases and sales are denominated in U.S. dollars, which limits our exposure to this risk. However, some of our foreign operations have a functional currency other than the U.S. dollar. To mitigate this risk, we hedge a portion of our foreign currency exposure with foreign currency forward contracts in accordance with our risk management policies. We do not enter into such contracts for speculative purposes. The assets or liabilities associated with the derivative financial instruments are measured at fair value and recorded in either other current assets or other current liabilities. As discussed below, the accounting for gains and losses resulting from changes in fair value depends on whether the derivative financial instrument is designated as a hedge and qualifies for hedge accounting in accordance with ASC 815, Derivatives and Hedging.

Cash Flow Hedges

We enter into foreign currency forward contracts designated as cash flow hedges (to sell Canadian dollars and purchase U.S. dollars) for forecasted inventory purchases in U.S. dollars by our Canadian subsidiary. These hedges have terms of up to 12 months. All hedging relationships are formally documented, and the forward contracts are designed to mitigate foreign currency exchange risk on hedged transactions. We record the effective portion of changes in the fair value of our cash flow hedges in other comprehensive income (“OCI”) until the earlier of when the hedged forecasted inventory purchase occurs or the respective contract reaches maturity. Subsequently, as the inventory is sold to the customer, we reclassify amounts previously recorded in OCI to cost of goods sold.

Changes in the fair value of the forward contract related to interest charges (or forward points) are excluded from the assessment and measurement of hedge effectiveness and are recorded in cost of goods sold. Based on the rates in effect as of January 29, 2023, we expect to reclassify a net pre-tax gain of approximately $0.9 million from OCI to cost of goods sold over the next 12 months.

We had foreign currency forward contracts outstanding (in U.S. dollars) with notional amounts of $18.5 million and $15.5 million as of January 29, 2023 and January 30, 2022, respectively.

Hedge effectiveness is evaluated prospectively at inception, on an ongoing basis, as well as retrospectively, using regression analysis. Any measurable ineffectiveness of the hedge is recorded in SG&A expenses. No gain or loss was recognized for cash flow hedges due to hedge ineffectiveness and all hedges were deemed effective for assessment purposes for fiscal 2022, fiscal 2021 and fiscal 2020.

The effect of derivative instruments in our Consolidated Financial Statements from gains or losses recognized in income was not material for fiscal 2022, fiscal 2021 and fiscal 2020.

The fair values of our derivative financial instruments are presented in other current assets and/or other current liabilities in our Consolidated Balance Sheets. All fair values were measured using Level 2 inputs as defined by the fair value hierarchy described in Note M.

We record all derivative assets and liabilities on a gross basis. They do not meet the balance sheet netting criteria as discussed in ASC 210, Balance Sheet, because we do not have master netting agreements established with our derivative counterparties that would allow for net settlement.

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Note M: Fair Value Measurements

Fair value is the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

We determine the fair value of financial and non-financial assets and liabilities using the fair value hierarchy established by ASC 820, Fair Value Measurement, which defines three levels of inputs that may be used to measure fair value, as follows:

  • Level 1: inputs which include quoted prices in active markets for identical assets or liabilities;

  • Level 2: inputs which include observable inputs other than Level 1 inputs, such as quoted prices in active markets for similar assets or liabilities; quoted prices for identical or similar assets or liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability; and

  • Level 3: inputs which include unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the underlying asset or liability.

The fair values of our cash and cash equivalents are based on Level 1 inputs, which include quoted prices in active markets for identical assets.

Foreign Currency Derivatives and Hedging Instruments

We use the income approach to value our derivatives using observable Level 2 market data at the measurement date and standard valuation techniques to convert future amounts to a single present value amount, assuming that participants are motivated but not compelled to transact. Level 2 inputs are limited to quoted prices that are observable for the assets and liabilities, which include interest rates and credit risk ratings. We use mid-market pricing as a practical expedient for fair value measurements. Key inputs for foreign currency derivatives are the spot rates, forward rates, interest rates and credit derivative market rates.

The counterparties associated with our foreign currency forward contracts are large credit-worthy financial institutions, and the derivatives transacted with these entities are relatively short in duration, therefore, we do not consider counterparty concentration and non-performance to be material risks at this time. Both we and our counterparties are expected to perform under the contractual terms of the instruments. None of the derivative contracts entered into are subject to credit risk-related contingent features or collateral requirements.

Long-lived Assets

We review the carrying value of all long-lived assets for impairment, primarily at an individual store level, whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. We measure property and equipment at fair value on a nonrecurring basis using Level 3 inputs as defined in the fair value hierarchy. We measure right-of-use assets on a nonrecurring basis using Level 2 inputs that are corroborated by market data. Where Level 2 inputs are not readily available, we use Level 3 inputs. Fair value of these long-lived assets is based on the present value of estimated future cash flows using a discount rate commensurate with the risk.

The significant unobservable inputs used in the fair value measurement of our property and equipment and right-of-use assets are sales growth/decline, gross margin, employment costs, lease escalations, market rental rates, changes in local real estate markets in which we operate, inflation and the overall economics of the retail industry. Significant fluctuations in any of these inputs individually could significantly impact our measurement of fair value.

Goodwill

We review each reporting unit's carrying value of goodwill for impairment annually, or between annual tests whenever events or changes in circumstances indicate that the fair value of a reporting unit may be below its carrying amount. We use the income approach, whereby we calculate the fair value based on the present value of estimated future cash flows using Level 3 inputs as defined in the fair value hierarchy. The process of evaluating the potential impairment of goodwill is subjective and requires significant unobservable estimates and assumptions about the future such as sales growth, gross margin, employment costs, capital expenditures, inflation and future economic and market conditions. Additionally, our quantitative impairment test uses a discount rate that approximates the reporting unit's weighted average cost of capital. Significant fluctuations in any of these inputs individually could significantly impact our measurement of fair value.

There were no transfers between Level 1, 2 or 3 categories during fiscal 2022 or fiscal 2021.

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Note N: Accumulated Other Comprehensive Income (Loss)

Changes in accumulated other comprehensive income (loss) by component, net of tax, are as follows:

(In thousands)Foreign Currency TranslationCash Flow HedgesAccumulated Other Comprehensive Income (Loss)
Balance at February 2, 2020$(14,593)$6$(14,587)
Foreign currency translation adjustments8,195—8,195
Change in fair value of derivative financial instruments—(315)(315)
Reclassification adjustment for realized (gain) loss on derivative financial instruments1—(410)(410)
Other comprehensive income (loss)8,195(725)7,470
Balance at January 31, 2021(6,398)(719)(7,117)
Foreign currency translation adjustments(4,488)—(4,488)
Change in fair value of derivative financial instruments—(247)(247)
Reclassification adjustment for realized (gain) loss on derivative financial instruments1—1,0241,024
Other comprehensive income (loss)(4,488)777(3,711)
Balance at January 30, 2022(10,886)58(10,828)
Foreign currency translation adjustments(3,572)—(3,572)
Change in fair value of derivative financial instruments—932932
Reclassification adjustment for realized (gain) loss on derivative financial instruments1—(341)(341)
Other comprehensive income (loss)(3,572)591(2,981)
Balance at January 29, 2023$(14,458)$649$(13,809)

1**Refer to Note L for additional disclosures about reclassifications out of accumulated other comprehensive income and their corresponding effects on the respective line items in the Consolidated Statements of Earnings.

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the shareholders and the Board of Directors of Williams-Sonoma, Inc.

Opinions on the Financial Statements and Internal Control over Financial Reporting

We have audited the accompanying consolidated balance sheets of Williams-Sonoma, Inc. and subsidiaries (the "Company") as of January 29, 2023 and January 30, 2022, the related consolidated statements of earnings, comprehensive income, stockholders' equity, and cash flows, for each of the three years in the period ended January 29, 2023, and the related notes (collectively referred to as the "financial statements"). We also have audited the Company’s internal control over financial reporting as of January 29, 2023, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of January 29, 2023 and January 30, 2022, and the results of its operations and its cash flows for each of the three years in the period ended January 29, 2023, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of January 29, 2023, based on criteria established in Internal Control — Integrated Framework (2013) issued by COSO.

Basis for Opinions

The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying “Management’s Report on Internal Control Over Financial Reporting". Our responsibility is to express an opinion on these financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.

Our audits of the financial statements included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures to respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

Definition and Limitations of Internal Control over Financial Reporting

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Critical Audit Matter

The critical audit matter communicated below is a matter arising from the current-period audit of the financial statements that was communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.

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Property and Equipment — Refer to Note A and M to the financial statements*.*

Critical Audit Matter Description

The Company performs an analysis of the carrying value of long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of the long-lived assets may not be recoverable. Events that result in an impairment review may include a significant decrease in the operating performance of the long-lived asset, or the decision to close a store, corporate facility, or distribution center. The Company’s evaluation of long-lived assets is primarily at the individual store level and involves the comparison of a store’s estimated future undiscounted cash flows over its remaining lease term to its carrying value. As of January 29, 2023, the Company had property and equipment, net of accumulated depreciation, of $1.1 billion, and operating lease right-of-use assets of $1.3 billion, certain of which relate to the Company’s stores. Impairment may result when the carrying value of a store’s assets exceeds the store’s estimated undiscounted future cash flows.

We identified property and equipment as a critical audit matter because the Company’s estimate of future store cash flows involves significant estimates and assumptions related to revenue growth rates and gross margin. Additionally, the measurement of any impairment loss also includes estimation of the fair value of the Company’s lease right-of-use asset included within the asset group, which includes estimates of market rental rates. Changes in these assumptions could have a significant impact on management’s conclusion on whether a store could be impaired and the impairment loss that is recorded.

Performing audit procedures to evaluate the appropriateness of the Company’s judgments used in these significant assumptions therefore involved a high degree of auditor judgment and an increased extent of effort, including the need to use more experienced audit professionals.

How the Critical Audit Matter Was Addressed in the Audit

Our audit procedures related to management’s judgments regarding the forecasts of revenue growth and gross margin, as well as the fair value of the right-of-use asset, included the following, among others:

  • We tested the effectiveness of controls over property and equipment, including those over management’s forecasts of future revenue growth, gross margin, and market rental rates.

  • We evaluated management’s ability to accurately forecast revenue growth rates and gross margin by comparing actual results to management’s historical forecasts to perform retrospective lookback of recent growth assumptions.

  • We evaluated the reasonableness of management’s revenue and gross margin by comparing the forecasts to (1) historical revenues and gross margins, (2) internal communications to management and the Board of Directors, (3) external communications made by management to analysts and investors, and (4) trends in the industry and geographical region.

  • We evaluated the methods and inputs used by management to determine the fair value of the lease right-of-use asset, including assessing comparable market rents, survey data, and broker quotes, as well as evaluating management’s sensitivity analysis regarding the change in market rents.

/s/ Deloitte & Touche LLP

San Francisco, California

March 24, 2023

We have served as the Company's auditor since 1980.

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